Journal Issue

Djibouti: Selected Issues

International Monetary Fund
Published Date:
March 2004
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Chapter I. The Financial System in Djibouti*

I. Introduction

1. Djibouti has had a currency board arrangement (CBA) since 1949, from the time when it was still a French territory. Being operated in a pure form, the central bank does not extend credit to the government, the banking system, or anyone else, and maintains foreign resources in excess of the value of its monetary liabilities. The CBA served well in keeping inflation at a low level and enabled Djibouti to maintain full convertibility into the U.S. dollar at a fixed exchange rate despite economic uncertainties throughout the eighties and nineties. However, Djibouti did not always implement policies and rules required for the smooth operation of the CBA. In particular, fiscal policy in the 1990s was expansionary (see Chapter II for more details), balance of payments was structurally in deficit, and the labor market was rigid. At the same time, Djibouti’s external competitiveness has deteriorated substantially and unemployment has risen significantly. Despite these difficulties, the CBA was maintained, supported by the ongoing financial liberalization, the large openness of the economy, and a deeply rooted respect for the CBA within the Djibouti society and political structure.

2. In spite of the obvious need for improved financial services in Djibouti and the efforts of the authorities to develop them, the financial system remains confined to performing a short-term financial function and has not sufficiently contributed to growth during the period from 1990 to 2002.2 The share of the financial sector in GDP remained at about 11 percent between 1990 and 2002,3 while the assets of the banking system stagnated at about 11 percent of GDP. The size of the financial sector dwindled as the number of commercial banks declined from five to three, while that of insurance companies declined from eight to two. This relatively noncompetitive banking system is now dominated by foreign-owned banks. Financial intermediation is still hindered by the lack of diversification both in terms of institutions and financial products, lending practices that aim to minimize risks, and a weak legal structure for contractual and property rights. Financial reforms introduced so far, including those under two Fund-supported programs, have had only a minor contribution in alleviating the impact of these factors.

3. This chapter reviews developments and the role of the financial system during the program period and discusses ways to enhance its effectiveness. Section II will review the CBA and its role in the macroeconomic developments and Section III will discuss the financial system and assess financial intermediation. Finally, section IV will discuss the main financial sector reforms, introduced since 1990, and explain why their impact has been limited so far. It then will suggest measures that could help improve the efficiency of financial intermediation and enhance the financial sector’s contribution to growth.

Box I.1:Financial Development and Economic Growth

Financial sector developments are critical to long-run economic growth. A number of economic studies have focused on exploring the channels through which financial development stimulates economic growth in the long-run (see Levine (1997), for a review of the literature). Most of these studies offered detailed arguments and evidence that a well- functioning financial system promotes economic growth by: (i) increasing the amount of financial savings through mobilization of financial resources; (ii) channeling these resources to the most profitable users, thus enabling an efficient allocation of resources; and (iii) ensuring an efficient operation of financial intermediaries by enabling them to operate at the lowest costs. Furthermore, a sound financial system benefits growth indirectly by ensuring a better transmission of monetary signals. These conclusions are also supported by various econometric studies, both time-series and cross-country (see Rousseau and Wachtel (1998); Beck et. al. (2000); Kularatne (2001)). For instance, Levine (1999) found from his cross-country study that a 10 percentage point increase in financial deepening (proxied by the credit to the private sector in percent of GDP) is likely to increase total factor productivity by about half a percentage point. Previous studies, such as Levine (1997), also found that legal and accounting reforms that strengthen creditors rights, contract enforcement, and accounting practices can boost financial development and accelerate economic growth.

While confirming the positive correlation between financial development and economic growth, some other studies found solid evidence suggesting that the direction of the causality is very much country specific, and not necessarily from financial development to economic growth.

For example, Demetriades and Houssein (1996) investigated a 16 country sample1 and found (i) very little support for the view that finance is a leading factor in economic development; (ii) that in quite a few countries, economic development causes financial development; and (iii) strong support of the view that the relationship between financial development and economic growth is bi-directional. Similar conclusions were drawn by Luintel and Khan (1999), who examined the long-run causality between financial development and economic growth in a multivariate time-series framework using data from a 10 country ample2 and found that (i) in the long run, financial depth is positively and strongly affected by the levels of per capita real income and the real interest rate; and (ii) a bi-directional causality between financial development and economic growth in all the sample countries analyzed.

1 These countries are Costa Rica, El Salvador, Greece, Guatemala, Honduras, India, Korea, Mauritius, Pakistan, Portugal, South Africa, Spain, Sri Lanka, Thailand, Turkey, and Venezuela.2 These countries are Colombia, Costa Rica, Greece, India, Korea, Malaysia, the Philippines, Sri Lanka, South Africa, and Thailand.

II. The Currency Board

4. Djibouti has had a currency board arrangement (CBA) since 1949, at a time when it still was a French territory. It is operated in a pure form, with foreign reserves being maintaned in excess of the value of the monetary liabilities issued by the Central Bank of Djibouti (BCD). The BCD does not exercise lender-of-last-resort (LOLR) functions, nor does it extend credit to the government, the banking system, or domestic companies (Box I.2) provides a general overview of CBA). Since its creation in March 1949, the Djibouti franc has been pegged to the U.S. dollar. It was revalued twice, in 1971 and 1973. As a result, the exchange rate is now DF 177.7 for one U.S. dollar, down from DF 214.4 for one U.S. dollar before 1971.

5. The CBA enabled Djibouti to maintain full convertibility into the U.S. dollar at a fixed exchange rate despite economic uncertainties throughout the 1980s and 1990s. It also allowed the country to emerge, on occasions, as a regional commercial and financial center. Over the years, the CBA has lent credibility to the country. While the government tried to maintain the integrity of the system, it occasionally turned away from the budget deficit financing constraints the CBA required. Nevertheless, the central bank kept the system consistent with external monetary developments, including monetary policy set by the U.S. Federal Reserve Bank. Operating under a 100 percent foreign reserve requirement and utilizing rule-bound monetary policy, transparency, and protection from political pressure, the CBA has helped Djibouti to maintain a relatively strong currency.

6. By binding its supply of base money closely to its holdings of reserve assets, the CBA has also served Djibouti well in keeping inflation at a low level, as it has in most countries where such an arrangement has been adopted.4 The inflation, as measured by the consumer price index, declined continuously from about 7 percent in 1991 to about 0.6 percent in 2002.5 Djibouti’s inflation evolved broadly in line with that of its main trading partners (Figures I.1a and I.1b), with the exception of Yemen, which experienced much higher price increases especially during the period 1995–2002 when inflation averaged 18 percent per year.

Figure I.1a.Djibouti and Trading Partner Countries: CP1 indices, 1990–2002


Sources: IMF, Information Notice System ; and staff calculations.

1/The composite CPI is a weighted average of Djibouti’s main trading partners’ CPI (Ethiopia, France, Italy, Saudi Arabia, United Kingdom and Yemen) using their trade share as weights.

Figure I.1b.Djibouti and Trading Partner Countries: CPI indices, 1990–2002


Sources: IMF, Information Notice System.

Box I.2:Conditions and Policy Implications for Currency Board Arrangement

A Currency Board Arrangement (CBA) maintains a permanently fixed exchange rate backed by the firm promise of the government of the establishing country to issue or redeem the local currency at a fixed rate against a foreign “anchor” currency. As a result, the money supply adjusts to the level of official gold and the inflows and outflows of foreign currency reserves, expanding or accelerating when there are net inflows, and contracting or decelerating when there are net outflows. The trigger for these monetary changes is typically price or interest rate differentials with the anchor currency economy (see Enoch and Guide (1997), and Hanke and Schuler (2000), among other studies dealing with CBAs).

Advantages and disadvantages of a CBA

One of the main advantages of a CBA is that compared to a full-fledged central bank, it is a cost-effective way of managing a monetary system. The CBA is also a strong, “double-barreled” device. Through the currency peg, it indicates a commitment to price stability, while at the same time refraining from being a lender-of-last-resort or expanding domestic credit. However, a CBA precludes the government from using monetary and fiscal policy to help offset economic cycles, especially on the downside. It also effectively removes both exchange rates and interest rates as instruments of government policy, surrendering them to the objectives of external exchange rate stability. Thus, the exchange rate is no longer a policy instrument that may be used to stimulate exports when needed, or to limit imported inflation when it threatens to raise domestic interest rates.

Key factors for successful currency board operations

A successful CBA is predicated on several conditions. First, the peg should be appropriate and supportive of acceptable levels of external competitiveness. The currency involved in the peg should be appropriate from the point of view of the country’s external trading pattern. Ideally, the reserve currency should be that of the country’s largest trading partner and largest potential source of new foreign investment. A second requirement is that there should be adequate flexibility in goods and factor markets e.g., in prices, wages, and economic structure to keep the system from breaking. Laws and regulations that protect domestic labor and keep labor costs high, including through costly social security contributions and other constraints, prevent the efficient reallocation of labor among industries. Third, there must be a free flow of goods and services, in addition to capital, across international borders to allow the price level to adjust fully to changes in the flows of international reserves. A fourth requirement is that a CBA should have adequate financial market supervision, risk assessment, and management so that financial institutions will be able to withstand the consequences of external shocks on interest rates. At the same time, bank supervision should follow best international practices in order to ensure high standards of bank governance and management, adequate loan ioss provisioning, and ongoing supervision of balance sheet risks (e.g., currency and maturity matching). In this regard, adequate official reserves are only one critical element of the preservation of confidence. A final necessity is that a CBA should maintain fiscal prudence, which implies a sound fiscal framework that does not require discretionary access to central bank financing by the general government, while maintaining public debt within limits of serviceability (see acccompanying paper on fiscal issues).

Policy Implications

For a CBA to be successful, the fixed exchange rate must be the sole fixed point surrounded by highly flexible, market-oriented systems. The maintenance of the currency board must be the top priority, with other policies designed to support it, not conflict with it. Any government’s reluctance or inability to conform to either the hard budget constraints or the free market principles which must accompany the adoption of a currency board would compromise the effectiveness of the CBA.

To what extent are the key factors for successful CBA operations met in Djibouti?

Djibouti has long maintained a fully open trade system with free capital transactions, and virtually zero external tariff. Also, the liquidity constraint, implied by the lack of a lender-of-last-resort, did not pose problems to banks that are subsidiaries of large foreign banking groups, access to international financing. Domestic banks with no such access, on the other hand, went through a liquidity crisis and were liquidated. Additionally, improvements to bank supervision over time have enhanced standards of bank governance and management, adequate loan loss provisioning, and ongoing supervision of balance sheet risks (currency and maturity matching etc). In this respect, the maintenance of adequate official reserves is only one critical element in the preservation of confidence. However, there is a lack of flexibility in other markets and prices that should accompany the holding of the value of the domestic currency absolutely fixed. In particular, Djibouti delayed the dismantling of many laws and regulations protecting domestic labor. Labor costs are very high for the region, and include onerous social security contributions, large severance payments, and other constraints that prevent the efficient re-allocation of labor between industries and downward adjustment in wages. Furthermore, fiscal discipline was not always observed, as evidenced by the accumulation of large amounts of domestic and external arrears during the 1990s.

7. Between 1990 and 2002, the hard peg to the dollar did not allow the economy to adjust as easily to external financial and real shocks. Included among these factors are oil shocks that affected the gulf countries, business cycles in other trading partner countries in Europe and in neighboring countries (especially Ethiopia and Yemen) and interest rate fluctuatations in the United States. Thus, while other countries in the region, most of which are potential competitors, experienced large exchange rate depreciations, Djibouti’s currency appreciated in effective terms (Figure I.2) and interest rates rose at a time when its economy was already suffering from recession, a loss of external competitiveness, and a worsening of the trade balance. Sticky wages and prices prevented the necessary adjustments to these shocks and further complicated the situation.

Figure I.2.Djibouti: Exchange Rate Developments, 1980–2003 1/


1/ Data for 2003 ate upto June only.

8. Notwithstanding the advantages of full convertibility of the Djibouti franc, other factors (including real effective exchange rate misalignment, an unfavorable business environment, and rigidities in the labor market) hindered foreign investment and economic growth. Looking at the period from 1990 to 2002, foreign investment remained below 1 percent of GDP. Real GDP declined by about half a percent on average per year and unemployment soared with more than half of the labor force out of work, leading to declining per capita income and rising poverty. At the same time, the real effective exchange rate appreciated by about 60 percent and interest rates remained at high levels.

9. Macroeconomic policies implemented by Djibouti during the 1980s and 1990s were not always consistent with the maintenance of a fixed exchange rate. In particular, against a background of civil strife, fiscal policy was expansionary and substantial payment arrears were accumulated. Fiscal reforms and other structural reforms stalled. Moreover, the labor market was rigid and the external competitiveness of the economy was slowly eroded, putting, at times, some pressure on the CBA. Thus, between 1994 and 1997 reserve adequacy ratios, measured by the monetary base (Ml)/foreign reserves and broad money (M2)/foreign resersves, increased by 7 percent (from 0.73) and 15 percent (from 1.18), respectively. At the same time, foreign currency deposits increased by 19 percent and their share in total deposits increased by about 15 percentage points (from 48 percent) pointing to some loss of confidence in the Djibouti franc during this period. There was also marked private capital outflows, as witnessed by negative BOP errors and omissions (including short-term capital flows) averaging 7 percent of GDP per year from 1996 to 1998. Consequently, two domestic banks ceased operations in 1999 after they failed to survive liquidity constraints and competition from two foreign-owned banks which had access to financing from their headquarters.

10. Starting in 1998, domestic and external factors helped reinforce the CBA. On the domestic level, the reestablishment of fiscal discipline and the implementation of some reforms, in the fiscal and other areas, contributed to curb and then reverse the rising trend in domestic budgetary arrears. In addition, external factors that generated additional resources and improved Djibouti’s economic situation, have included increased transit trade with Ethiopia, following the war between Ethiopia and Eritrea, resumption of sustained external support (program-related funding by the World Bank, Fund programs, European Union, and France) and the financial windfall received by Djibouti for its cooperation in the fight against terrorism. However, the deeply rooted respect for the CBA within the Djibouti society and political structure has played a significant role in the maintenance of the CBA.

III. The Financial System

11. In addition to the CBA, the Djibouti financial system today consists of three commercial banks and a limited number of nonbank financial institutions. The latter include six money changers and two insurance companies dealing in car, business, and various shipping-related insurance services.6 There is no domestic capital market that could bring together entrepreneurs and investors, who would seek placement opportunities and be prepared to take risks.

A. The Banking System

Current setting and features

12. The Djibouti financial sector has remained confined to providing short-term financial services and performed weakly in comparison with other small states and neighboring countries. For illustration purposes, Table I.1 presents comparative data on financial depth of Djibouti vis-à-vis other small states and neighboring countries (Ethiopia, Yemen, and Egypt), and two African countries (Ghana and Kenya). This table indicates that Djibouti’s performance was weaker than most of its comparators on most indicators between 1990 and 2002: it experienced a lower financial intensity as evidenced by lower broad money growth, broad money-to-money ratio, growth of credit to the private sector, growth of total deposits, and lower share of time deposits in total deposits.7 During the same period, real GDP growth declined about 0.5 percent per year in Djibouti, while annual growth reached an average of 3.5 percent in the other small states and even higher levels in the other comparator countries.

Table I.1.Djibouti: Selected Financial Indicators, 1990–2002

Broad money growth (Annual percentage change)
Small states 1/2/19.815.613.913.826.818.313.518.69.512.315.410.210.315.2
Yemen. Republic o f-11.320.931.132.550.
Ratio of broad money to GDP (In percent)
Small states49.851.949.649.850.451.752.754.656.556.559.
Yemen, Republic of55.551.548.751.452.447.536.233.539.032.430.934.737.442.4
Ratio of broad money to money (In percent)
Small states3.
Yemen. Republic of1.
Credit to private sector growth (Annual percentage change)
Small states17.816.515.116.117.820.416.724.814.910.410.78.716.315.9
Yemen, Republic of-12.715.326.011.868.7-6.353.833.735.821.325.814.326.1
Total deposit growth (Annual percentage change)
Small states12.614.
Yemen, Republic of-11.617.516.215.5112.222.216.520.014.432.023.325.327.2
Ratio of Time deposits to total deposits (In percent)
Small states70.670.870.670.070.770.670.
Yemen, Republic of50.350.345.344.543.375.876.478.680.684.083.383.686.867.9
Sources; Djibouti authorises; and IMF, International Financial Statistics and World Economic Outlook.

Small States are: Antigua and Barbuda. The Bahamas, Bahrain, Barbados, Belize, Bhutan, Botswana, Cipe Verde, Comoros.Cyprus, Dominica, Equatorial Guinea, Estonia, Fiji, Gabon, The Gambia, Grenada, Guinea-Biasau, Guyana, Maldlives, Malta, Mauritius. Qalar, Samoa, Slo Tome & Principe, Seychelles, Solomon Islands, St.Kitts and Nevis. St.Lucia, St.Vincent & Grens., Suriname, Swaziland, Tonga, Trinidad and Tobago, and Vanuatu.

Simple average.

Sources; Djibouti authorises; and IMF, International Financial Statistics and World Economic Outlook.

Small States are: Antigua and Barbuda. The Bahamas, Bahrain, Barbados, Belize, Bhutan, Botswana, Cipe Verde, Comoros.Cyprus, Dominica, Equatorial Guinea, Estonia, Fiji, Gabon, The Gambia, Grenada, Guinea-Biasau, Guyana, Maldlives, Malta, Mauritius. Qalar, Samoa, Slo Tome & Principe, Seychelles, Solomon Islands, St.Kitts and Nevis. St.Lucia, St.Vincent & Grens., Suriname, Swaziland, Tonga, Trinidad and Tobago, and Vanuatu.

Simple average.

13. Financial intermediation in Djibouti is fairly weak and dominated by foreign-owned banks. Following the closures of two other commercial banks (Banque Al-Baraka and Banque de Djibouti et du Moyen Orient (BDMO)) in the late 1990s, owing to continued liquidity problems, the banking sector is now dominated by two large French-owned commercial banks, Banque Pour le Commerce et l’Industrie Mer Rouge (BCI) and Banque Indosuez Mer Rouge (BIS), which together account for about 95 percent of total deposits and issue more than 85 percent of total credit. As a result of a weakened loan portfolio, activities of the third operating bank, the local subsidiary of the Commercial Bank of Ethiopia (CBE), are largely limited to deposit-taking and international transactions conducted by Ethiopian customers.

14. Financial intermediation is costly to those soliciting funds and lending practices aimed at minimization of risks. For instance, the banks demand marketable collateral in a country where assets are few and illiquid. Also, the spread between lending rates and deposit rates is high and almost twice what prevails in neighboring Ethiopia, and a percentage point higher than spreads in Yemen and in other small states. As a result, the two large commercial banks operate very much like traditional savings banks (caisse d’épargne), with a focus on deposit collection and only very limited credit activity. Credit to the private sector has been declining due to limited opportunities in the real sector, deficiencies in accounting standards, and a weak judicial system. Gradually, banks have shifted the structure of their assets toward foreign assets held with their parent companies.

15. Bank lending remained low, exhibiting some volatility in the early 1990s, and has been declining since 1999, despite a noticeable increase in deposits during the same period. The deposit transformation rate,8 depicted in Figure I.3 below, remained above 70 percent during most of the 1990s but has been declining sharply since 1999, reaching about 50 percent in 2002, down from a peak of 90 percent in 1999. This trend may be explained mainly by uncertainty about government policies, law investment profitability in Djibouti, and a slowdown in trade activities.

Figure I.3.Djibouti: Total Bank Deposits and Credits, 1990–2002

Source: Djibouti authorities; and Staff calculations.

16. Bank lending distribution is reasonably concentrated in terms of beneficiaries, activities, maturities, and the customer base remains modest. About 60 percent of total loans are extended to the trading sector and 19 percent to individuals (mostly for mortgages), while industry and energy receive barely 7 percent of these loans (Figure I.4 and Table I.3).9 Short-term lending represents about 75 percent of total lending, and long-term lending averages about 10 percent. It is also estimated that the two main commercial banks together have about 150 large customers with a credit volume exceeding DF 15 billion; their relations with the largest 50 customers play a key role in determining overall lending volumes.

Figure I.4.Djibouti: Credit Distribution, October 2002

Sources: Central Bank of Djibouti; and staff estimates.

Table I.2.Djibouti: Selectoral Distribution of Credits 1/(In millions of DF)
Agriculture and fishing000000
gas retailers, vehicules,1,9872,2662,1192,0951,4682,094
consumption goods17,18714,70115,56116,50015,71312,760
Hotels and restaurants1932671,6381,999417210
Transport and communication7361,6772,162748753855
Other sevices1,2071,0982,8872,6201,5011,254
(In percent of total credits)
Agriculture and fishing0.
gas retailers, vehicules6.
consumption goods54.848.543.547.550.350.9
Hotels and restaurants0.
Transport and communication2.
Other sevices3.
(Annual changes in percent)
Agriculture and fishing------
gas retailers, vehicules,…-14.0-6.5-1.1-29.942.7
consumption goods--
Hotels and restaurants-38.2513.122.1-79.2-49.5
Transport and communication-127.928.9-65.40.813.5
Other sevices--9.0162.9-9.2-42.7-16.4
Source: Central Bank of Djibouti.

Beneficiaries, for 1997–2000 credits of 10 million DF and more are listed; and from 2001 credits of 3 million DF and more are listed.

2/ Preliminary figures for 2002, as of October 2002.
Source: Central Bank of Djibouti.

Beneficiaries, for 1997–2000 credits of 10 million DF and more are listed; and from 2001 credits of 3 million DF and more are listed.

2/ Preliminary figures for 2002, as of October 2002.
Table I.3.Djibouti: Deposits Structure, 1990–2002
A. Structure by maturity
(In millions of Djibouti francs)
Short-term deposits15,92917,92420,54322,06820,72919,76518,43715,73017,78319,86218,50017,31124,225
Medium-term deposits1,8272,1873,1092,9683,0652,8622,9583,1603,3343,5063,7834,3244,651
Long-term deposits22,91019,57315,40113,50713,10113,34810,57710,82010,9559,89111,16812,22312,563
Cash bond/voucher6,4176,1915,5896,8438,01412,10511,05611,60513,17013,33415,54217,68919,089
Total banking system47,08345,87644,64245,38644,90848,08043,02741,31445,24246,59348,99351,54760,528
(In percent of total deposits)
Short-term deposits33.839.146.048.646.241.142.838.139.342.637.833.640.0
Medium-term deposits3.
Long-term deposits48.742.734.529.829.227.824.626.
Cash bond/voucher13.613.512.515.117.825.225.728.129.128.631.734.331.5
Total banking system100.0100.0100.0100.0100.0100.0100.0100.0100.0100.0100.0100.0100.0
(Annual changes in percent)
Short-term deposits-12.514.67.4-6.1-4.7-6.7-14.713.111.7-6.9-6.439.9
Medium-term deposits-19.742.2-4.53.3-
Long-term deposits--14.6-21.3-12.3-3.01.9-
Cash bond/voucher--3.5-9.722.417.151.1-
Total banking system--2.6-
B. Structure by Depositor
(In millions of Djibouti francs)
Private companies8,33510,43211,70112,2669,9219,4389,2838,57310,69812,75921,84423,78014,677
Public enterprises10,0169,1605,7195,8906,6625,1353,2551,9881,3761,1571,7631,6602,458
(In percent of total deposits)
Private companies17.722.726.
Public enterprises21.320.012.813.014.810.
(Annual changes in percent)
Private companies-
Public enterprises--8.5-
Sources: Djibouti authorities; staff calculations
Sources: Djibouti authorities; staff calculations

17. Banks lend primarily to the trading community, and loans are not easily available to other customers such as small businesses. Against the background of economic uncertainties, lack of profitable projects, and increasing nonperforming loans (NPLs), commercial banks are cautious when granting credit and impose stringent conditions when they do so. As a result, small operators, particularly those engaged in the informal sector, do not have access to bank lending because they often fall short of meeting all the stringent qualification criteria set by banks. In the absence of alternative sources of financing, small projects that are more commensurate with the size of domestic markets, and which can be labor-intensive, are often abandoned.

18. To promote access to financing for small, long-term projects, the authorities established in 1983 the Djibouti Development Bank (BDD), which was the only specialized bank in Djibouti. The BDD faced serious difficulties mainly due to poor supervision and increased government interference in its operations. As a result, the assets of the BDD were frozen beginning in 1996, owing to the growing number of NPLs in its portfolio, and an early dissolution of the BDD was decided in 2000. More recently, the government authorized, in 2001, the creation of a Development Fund for Djibouti (FDD) to promote access to credit for small- and medium-sized companies. The FDD’s objective is to grant direct loans, using its own funds and resources borrowed overseas, to private sector operators, especially in the tourism, fisheries, and agriculture sectors, with priority given to rural development and microcredits. Its mission is also to provide technical assistance in the area of project development. However, the FDD is not yet fully operational.

19. Current trends in bank lending are also determined by the structure of demand for credit. In addition to enterprises eligible for banks’s financing, there are, in Djibouti, two major categories, which potentially need financing but are excluded from bank financing. The first group includes operators performing low income-generating activities (such as small traders, small handicrafts, and service providers, which are usually self-run) and responds to demands for goods and services by low income and poor families in a flexible way and at competitive prices. These operators are excluded from bank credit because the amount of loans they require is usually low and incur high transaction costs that banks are unwilling to assume. Additionally, the absorption capacity of these operators is low in view of the their limited activity and, because of their precariousness, they cannot provide the collateral required by banks. The second group includes investors with some financing capacity, who are eligible for development funds. While they are capable of applying to banks for credit, these operators are discouraged by banks’ stringent conditions and collateral requirements. Banks could increase their operations with these operators if (i) the juducial system became more efficient and responded in a timely manner, leading banks to soften their conditionality; and (ii) adequate financial products and a regulatory framework are developed.

The soundness of the banking system

20. While available data indicate that Djibouti’s financial system is broadly sound, in the recent past, the quality of bank assets was negatively affected by weak economic developments in Djibouti, sharp declines in the housing market, and political conflicts in neighboring countries. For the banking system as a whole, the share of NPLs (including provisions for NPLs) increased from about 23 percent in the 1990s to about 26.5 percent at end-2002. Capital adequacy and risk diversification ratios were generally met by the two dominant commercial banks, BCI and BIS.10 At the same time, there were some differences in terms of risk exposure and performance between the two banks. While the share of NPLs to total loans is similar in both banks, they differ in terms of loan loss provision. Reflecting partly higher provisions for loan losses in one bank, return on equity and return on assets were lower than the other bank. Overall, profitability of banks has remained low on account of the still substantial amount of NPLs on their books.

21. In 2002 more than 80 percent of bank revenue came from net interest income. Limited competition in the small banking sector has helped banks manage their interest income and stabilize profit developments. Because of the small size of the banking market, the monetary authorities have been concerned for a long time that there is a risk of collusion among banks in setting interest rates. In August 1999, the BCD instructed banks to cease their coordination of interest rate structures and to publicize and report their structures to the BCD (section IV). However, recent interest rate developments suggest that banks may still use their market power to some degree. Whereas minimum deposit rates declined from 3.9 percent in 2000 to 1 percent in 2002, in line with international rates, minimum lending rates remained at 10.8 percent, thus further widening the interest rate spreads. Currently, there is no evidence supporting the idea of a liquidity crunch in the Djibouti banking system. There are limited lending opportunities which, coupled with a very cautious lending approach by commercial banks, lead to a significant amount of net foreign assets that are placed by the latter with their parent banks.

22. Notwithstanding the improvements that took place over the recent years, the banking sector in Djibouti still exhibits a few vulnerabilities that need to be addressed. First, one of the commercial banks still fails to meet a number of prudential regulations and the other hardly meets any of them. Failure to quickly and decisively address this issue may ultimately have negative effects on the integrity of the banking system. Second, the large share of interest income from foreign assets in revenues (over 25 percent of total revenues) might involve some risks over the medium term, particularly if competition in the banking sector increases. Similar risks may exist if international interest rates remain low over a long period of time. If this were to occur, and if competition in the banking sector were to increase, leading to a narrowing of domestic interest margins may narrow (given the tight link of domestic rates to international rates) and banks would have to cut costs or find other sources of income to avoid losses. Recent experience shows, actually, that the two main commercial banks managed to more than offset the decline in interest incomes by increasing commissions and other fees for customers’ operations. Third, the liquidity and solvency of the banking system could also be threatened by a banking crisis in the country of origin of the parent institutions or in a major trading partner country of Djibouti. While not very likely, such a crisis would have a large impact on the Djibouti banking system.

B. The Money Changers

23. In addition to the three commercial banks, there are currently six money changers in Djibouti. Some of them have been in operation since 1948, beginning as small enterprises focused on servicing the business of their owner and expanding over time. They often operate in an informal manner, and their operations are traditionally limited to the sub-region and the Arabic peninsula, given Djibouti’s dependence on these countries. Their working procedures remain largely outdated despite the increasing volume of activity.

Their role in financial intermediation

24. The money changers offer currency exchange and international transfer services, even to clients with no bank account. The currency exchange activity is limited to Djibouti and does not involve transactions with other countries. Nevertheless, when the foreign currencies needed are not available in the domestic banking system, the money changers call upon regional commercial banks to satisfy their need or, in some cases, travel to purchase and repatriate the needed foreign currencies. For currency transfers, the money changer issues a transfer order to the beneficiary, either a subsidiary in the country of the beneficiary, if any, or order the bank, in which it has an account, to make the transfer in question.

25. The money changers play an important role in financial intermediation. Based on the 2001/2002 on-site supervision, the money changers handled about 17 percent of total financial transfers abroad and about 7 percent of transfers received by Djibouti. About 45 and 40 percent of receivable transfers originate from U.A.E and Yemen, respectively, the remaining come mostly from Saudi Arabia and Ethiopia. About 90 percent of these transfers are in U.S. dollars and the rest in Djibouti francs and Ethiopian birrs. The currency composition of transfers payable is about 66 percent in the U.A.E dirham, 20 percent in the Saudi Arabian rial, and 10 percent in the U.S. dollar. The money changers are appealing because they perform several useful functions, as they: (i) operate on somewhat smaller spreads and charge lower commissions than the commercial banks; (ii) deal with all types of customers and are more flexible than banks in terms of working hours; and (iii) are more specialized in their operations than banks, which operate a broader range of activities.

The soundness of money changers

26. While the responsibility for supervision of the money changers is vested in the BCD, their activities remained largely unmonitored until recently. After the events of September 11, and in line with the intensification of the international fight against terrorism and money laundering, the BCD launched, in end-2001 and early 2002, a vast on-site supervision of all money changers. To further enhance supervision, the authorities adopted in 2002 a law on money laundering, confiscation, and international cooperation with regard to the proceeds of crime. At the same time, they prepared revised banking laws which provide for more regular on-site supervision and a systematic control of all money changers.11

27. The first on-site supervision undertaken in 2001/2002 concluded that the existing money changers operate broadly in full compliance with the existing regulations and gained a valuable know-how through years of experience. Most of them rely on correspondent networks that impose sufficient financial guarantees and soundness. Nevertheless, the inspection team of the BCD recommended that the money changers do the following: (i) computerize their data and improve their maintenance; (ii) gradually introduce recent accounting practices to keep up with their growing activities; and (iii) request, if necessary, technical assistance from the BCD regarding accounting and regulatory practices.

C. Informal Financial Arrangements

28. Outside the formal sector, there also exists informal finance in the form of traditional arrangements. Informal finance is understood in this context as contracts or agreements conducted without reference or recourse to the legal system in order to exchange primarily cash in the present for promises of primarily cash in the future.12 These arrangements are used by low-income participants for pooling small savings and extending small credits. Box I.3 provides an overview of the main features and activities of the three main forms of arrangements existing in Djibouti.

29. The three forms of traditional arrangements have several advantages and weaknesses. The success of the informal systems stems principally from ensuring (i) low transaction costs; (ii) supply of loans, savings, and implicit insurance; (iii) services that are sensitive to constraints faced by women, in particular their inability to obtain formal financing; (iv) substitution of confidence in character for physical collateral; and (v) socially enforced and/or self-enforced contracts. While these forms show how those excluded from the banking system fashion their own financial instruments in the absence of formal services, they have several weaknesses that should not be overlooked, including (i) lack of deposit insurance; (ii) operation within a limited group based solely on individual savings and inability to satisfy the financing demands for economic activities which exceed available savings; (iii) limited proportion of savings invested and only on a short-term basis because of its very nature; and (iv) impossibility of recourse to a legal system that enforces contracts.

D. Microcredit Programs

30. Microfinance corresponds, in this context, to formal schemes designed to improve the well-being of the poor through better access to saving services and loans. Thus, both informal finance and microcredit aim at serving the poor. However, they differ to the extent that informal finance derives from the need of those excluded from the formal finance for financial services and loans, while microfinance is impulsed by a donor-driven supply of financing. Lessons drawn from informal finance are usually very instructive for the design of microfinance.

31. Although microfinance in Djibouti started a decade ago, it is still at an early developmental stage. Microfinance started with the French Development Agency’s (AFD) program (Programmes Aide aux initiatives de Base), which benefited, between 1992 and 1995, 32 small- and medium-sized enterprises, engaged in activities such as hotels, fisheries, bakeries, and small manufacturing enterprises. The project failed for various reasons, including the absence of reliable information about the solvency of beneficiary firms; the lack of experience of the AFD in microfinance; insufficient human and financial resources to manage and monitor the program; and a judicial system lacking the ability to enforce contracts, as evidenced by the fact that only two enterprises have fully reimbursed their loans.

Box I.3.Informal Financial Arrangements1

Three forms of arrangements exist in Djibouti. The first traditional arrangement is revolving savings and credit associations, also known as tontines. The most widespread type in Djibouti is the mutual tontine, which is organized around the principle of solidarity between members who know each other well. This is a financial association created between people who decide to pool their savings and take turns in accessing the said pool. Each of the members gets the pooled money according to a pre-established order, which can be subject to change. Every member can also lend money or take out a loan. In principle, debts are not subject to interest. A mutual tontine is a system that primarily helps members accumulate their own savings on a daily basis, or over a period of one week or one month.2 Participants generally pay their share according to the time horizon they choose, with higher contributions for longer time horizon (daily contributions are lower than weekly ones, which are, in turn, lower than monthly contributions).3 The average size of a tontine is nine participants, of which about 85 percent are women. The membership usually brings together friends (20 percent coworkers), neighbors (40 percent), and coworkers (60 percent). About 20 percent of the existing tontines are daily, 30 percent weekly, and half of them are monthly. The second form of traditional arrangement is the credit to wage earners (Bill or Masrouf), which is widely used in the capital city. Small loans are extended to participants for fixed fees to pay for their daily expenses. These loans are then reimbursed by participants at the end of the month when they usually receive their salaries. The final financial arrangement is the retailer credit. In this situation, some traders entrust peddlers or retailers, who do not have working balances at their disposal, to sell some goods door-to-door or in their shops. The sale income is then paid to the original traders for a fixed commission.

1 Source: Djibouti authorities.2Tontines are known in virtually all African countries. They are diverse and have different names depending on the country or even regions within the same country: Esu or Adjo in Benin and Niger, for example. There are three types of tontines: the mutual tontine, the financial tontine, and the commercial tontine.3 In 1995 the shares paid by participants were estimated at S3 for a daily tontine, $23 for a weekly tontine, and $89 for a monthly tontine.

32. A similar project was launched by Caritas Internationalis (CARITAS) between 1996 and 2000. The approach used was similar to the Bangladesh Grameen Bank’s.13 It was based on the voluntary formation of small groups of four people to provide mutual, morally binding group guarantees in lieu of the collateral required by conventional banks. The project benefited 800 women, who received small loans (on average $600 over a period of one year with a 10 percent interest rate) totaling about $709,000. The project ended in 2000 for similar reasons as the AFD program did. Following the CARJTAS approach, a microcredit program was launched by the Social Development Fund (FSD) in 2001. The program was financed by the African Development Bank and promotes income-generating activities by granting microcredits to women. The implementation of the program is entrusted to nongovernmental agencies (NGAs) and financed by the FSD, which also provides support in terms of methodology, training, management, and computerization. The women who participated live in the capital and three other cities (Tadjourah, Obock, and Ali Sabieh). They each received between $ 170 and $560. The program benefited 800 women, who obtained loans totaling about $113,000.

33. A more recent initiative was the creation in 2001 of the FDD, presumably to replace the Djibouti Development Bank which was liquidated in 1999. The FDD has yet to start operations. Furthermore, in 2002 the International Fund for Agriculture and Development (IFAD) conducted a study on the feasibility of rural microfinance, but this project is still under examination.

34. The development of microfinance in Djibouti has been hindered by the lack of a regulatory framework, a weak judicial and fiscal environment, resource constraints, and the lack of institutional support. Presently, microfinance activities remain largely unregulated. However, since the 2000 banking law alludes to adjustments necessary to regulate microfinance activities,14 it is presumed that the BCD is aware of the need to develop a legal framework for microfinance institutions. The existing legal system is weak and often fails to enforce contractual and property rights. There is a limited knowledge of judiciary rules, only a few justice professionals, and frequent political interference in the functioning of justice. In addition, most microfinance institutions existing in Djibouti are largely subsidized, operate with insufficiently trained staff, and have not yet defined clear development plans. Furthermore, their accounting and management systems are poorly developed. While the government has been paying attention to the microfinance sector for sometime, the initiatives taken so far (e.g., by setting up various working groups) have failed to put in place a framework where the various actors in this sector could exchange views. As a result, there exists a variety of dialogue frameworks that hardly reach an operational stage, presumably due to the absence of a clear understanding of the roles of different structures involved, and the lack of human resources and competencies in this area.

IV. Financial Sector Reforms and Growth Issues

35. To maintain the integrity and effectiveness of the financial system, the authorities took, in the last 12 years, a number of measures covering three main areas, namely the legal framework, supervision and prudential regulations, and financial intermediation. However, these measures were mostly driven by the requirements of donor-supported programs (including programs with the Fund) and were not really part of a comprehensive financial sector reform program. Furthermore, these measure were not very ambitious and their implementation was slower than initially envisaged. As a result, they have had only limited impact so far and additional efforts would need to be made to strengthen the financial system and improve Djibouti’s attractiveness as a regional commercial and financial center. These efforts should focus again on the areas mentioned above but also should aim at improving contractual property rights and deepening the financial sector.

A. The Legislative Framework

36. Revised banking law and central bank statutes were adopted by parliament in June 2000 and replaced previous laws dating back to 1985. The 2000 banking law introduced four main provisions. First, for a new banking institution to operate, at least 30 percent of its capital should be owned by a sound foreign banking institution (against 20 percent in the 1985 law). Second, each bank should conduct regular internal audits and report the results to the BCD. Third, the annual on-site supervision of each bank by the BCD should be undertaken annually. Fourth, disciplinary actions should be taken against banks’ management members in case of misconduct. As a result of this law, report requirements to the BCD by all banking institutions on their activities in detail were also strengthened.15 However, the new laws contained a number of weaknesses, including inadequate rules for setting up new financial institutions; a failure to specify sanctions for banks not in compliance with banking regulations; and operating rules for the central bank which would permit the extension of commercial and other credits to private, nonfinancial institutions.16 Legislative amendments to correct these shortcomings were prepared in the context of the PRGF program in 2002. The revised draft laws, which also include institutionalization of the external auditing of the BCD’s accounts mechanism, was submitted to the cabinet for approval in late 2002 but are yet to be adopted by the latter and by the national assembly.

37. In the same vein, the government adopted in September 2002 a new law on money laundering, confiscation, and international cooperation with regard to the proceeds of crime. This law provides Djibouti with a sound legal framework that should be used to ensure continuous monitoring of the integrity of the financial system. The authorities are also pursuing their efforts to increase the awareness of financial institutions of money laundering issues, updating the regulatory framework for financial operations, and enhancing the capabilities of the financial investigations unit at the BCD. The next step would be to expedite the adoption of the new revised banking laws to correct existing flaws in the current laws; and implement measures to combat money-laundering and fully comply with the UN resolutions.

B. Supervision and Prudential Regulations

38. The authorities have made headway in improving the supervisory capabilities of the BCD, for both off- and on-site supervisory capabilities. This was achieved through personnel training, and with external technical assistance including from Fund resident advisors. In regard to off-site supervision, conducted at least once a year, the Djibouti banking regulations include a comprehensive set of prudential ratios for banks. The requirements for these ratios take into account the country-specific context17 by being more strict than the general internationally accepted capital adequacy and risk diversification standards. On-site supervision of commercial banks started in 1996 and aims at inspecting each financial institution once a year. However, due to administrative capacity constraints, the BCD was able to supervise on-site only one bank per year so far. The BCD completed, for the first time, controls of all the money changers operating in Djibouti between end-2001 and early-2002, and plan to inspect them in the future once a year. To this end, the BCD started a program to train its staff, including recent recruits, with the support of the Banque de France.18 In addition, a Fund expert visited Djibouti in December 2002 and provided practical assistance and training for on-site supervision. The BCD is also approaching other donors to fund the training program.

39. To improve transparency of the central bank, the monetary authorities have taken steps to regularly audit the annual financial statements of the BCD in accordance with International Standards on Auditing (ISA). In this connection, a new external auditing firm audited the BCD accounts for 1999, 2000, and 2001 in December 2002. The same auditing firm will conduct the audit of the BCD accounts for 2003 and 2004, thus covering a five-year auditing period.

40. Notwithstanding the progress achieved so far, the authorities are encouraged to pursue efforts aimed at strengthening the banking supervision. In this connection, the BCD should extend its training program to include various banking issues19 so as to improve the capacity of its staff to keep abreast of all developments in the financial system. Money changers should also benefit from training courses organized by the BCD, especially on accounting procedures and standards, and be kept abreast of developments involving their activities, such as changes in financial regulations and implementation of the law on money laundering.

C. Financial Intermediation

41. Sound financial intermediation for the benefit of all operators remains a central area for further reform. To better assess some of the risks that banks are facing in their financial intermediation activities, a series of measures were implemented in 1991. A Risk Office (Centrale des Risques) was established, which centralized the accounting of about 80 percent of outstanding bank credits above a minimum level (DF 10 million for commercial banks and DF 5 million for the development bank); in addition, the BCD had initiated the establishment of a data base on outstanding checks without cover.20 A government decree requiring the submission of such information was adopted at the same time. However, these initiatives were limited in scope and could not by themselves encourage the banks to be more active in the domestic market.

42. In 2001, in an effort to supplement the commercial banks in providing financing to investors, a presidential decree authorized the creation of a development fund(Fonds Djiboutien de Developpement, or FDD). This fund is a public enterprise under the supervision of the ministry of finance which is expected to use concessional lines of credit from bilateral, multilateral, and private sources in order to extend credit to small- and medium-sized enterprises, especially in the tourism, fisheries, services (commerce, handicraft, transport) and agriculture sectors. The investment program of the FDD for the period 2003–10, estimated at about $35 million, would be financed by the Djibouti government (5 percent), the domestic private sector (25 percent), and international organizations (70 percent). However, there was a concern about the possible profitability of the fund and the government emphasized the importance of not providing it with guarantees.21 Furthermore, the FDD is not subject to supervision by the BCD, which could generate similar difficulties to the one that led the BDD to cease its operations in 1996. Similar attempts in other African countries, such as Kenya and Nigeria, which set up development financial institutions to provide long-term loans, have failed mainly due to lack of independence of these institutions from government interference, difficulties in selecting the beneficiaries, fraud and mismanagement, and weak supervision.

43. To broaden financial activities in support of their national poverty reduction strategy, the authorities have also taken initiatives to develop microcredit programs. These initiatives aim at establishing institutions that grant direct loans, using their own funds and foreign borrowing, to private sector operators, especially to small operators that usually do not have access to bank lending. However, these institutions can only fulfill their mission if an adequate regulatory environment is put in place. It is also important that these institutions be regularly supervised by the BCD in order to establish healthy relationships with the beneficiaries of microcredits.

D. Other Measures and Developments

44. In view of the difficulties faced by the banking system in enforcing loan agreements, reflecting essentially weaknesses in the judicial system, the BCD established in July 1999 a notification system under which banks are prohibited from lending to defaulting borrowers, whose nonperforming credits exceed a threshold amount and who are in arrears, until their loans are regularized. However, the steps undertaken to expedite the judicial process for bank recovery of nonperforming bank loans did not progress as envisaged.

45. Outstanding weaknesses in the enforcement of loan agreements combined with mismanagement hindered the viability of two commercial banks, the Al Baraka Bank and the BDMO, which were placed in liquidation in 1998 and at end-1999, respectively. The recovery of these banks’ debts and the gradual reimbursement of depositors has been somewhat slower than anticipated owing to a number of judicial delays and other constraints. In addition, the authorities experienced difficulties in liquidating assets, mostly in the form of real estate.22

46. The weak legal structure for contractual enforcement and property rights likely have a significant impact on the behavior of the financial sector.23 The court system does not seem to enjoy the confidence of the private sector. Judges are perceived as lacking autonomy. Furthermore, the court system is also slow in resolving disputes. A good illustration is the lengthy liquidation of the two banks just mentioned which has yet to be finalized. While some of these problems are due to lack of financial and human resources, others result from political interference in the functioning of the judicial system. The authorities rightly recognize the importance of improving the legal system to ensure success to their national poverty reduction strategy, but would need to expeditiously take concrete measures in this direction.

47. Financial products available in Djibouti are limited and consist mainly of deposits with commercial banks. Recently, one of the banks launched an initiative to encourage small consumer credits, focusing on credits to employees of employers with a good reputation, such as the port. While it is too soon to draw firm conclusions from this initiative, the bankers find the results encouraging. To ensure greater mobilization of domestic savings, another area of reform would be the development of new financial products. However, the success of such an operation hinges on the establishment of an adequate regulatory framework. Therefore, a well-sequenced work program would first identify a set of products suitable for local customers, and then tailor a regulatory framework. On both aspects of the operation, technical assistance must be sought.

V. Main Conclusions

48. The Djibouti financial sector has yet to achieve a more effective role in the Djibouti economy and could be further strengthened. The level of financial intermediation in the economy remains relatively modest. Banking soundness indicators portray a mixed picture, as banks seem to be well capitalized and profitable, while NPLs ratios continue to be high. There are no domestic banks to help extend banking system services beyond the major metropolitan areas and to small- and medium-size enterprises.

49. To enhance the effectiveness of the financial sector and maintain its integrity, the authorities have made progress in the last 12 years in the implementation of a number of measures covering the legal framework, supervision and prudential regulations, and financial intermediation. The new AML law, adopted in 2002, provides Djibouti with a sound legal framework that should be used to ensure continuous monitoring of the integrity of the financial system. The revised banking laws, expected to be adopted in 2003, will introduce clearer regulations for the operation and establishment of financial institutions, and enhance transparency by institutionalizing the external auditing of the BCD’s accounts mechanism.

50. However, further measures are needed to help remove bottlenecks to the expansion of credit to the private sector and to consolidate supervision practices, promote microfinance, facilitate lending to the private sector, and encourage a generation of long-term savings. Such measures could include:

  • Putting in place a comprehensive training program for the supervisory staff at the BCD and the other financial institutions, thus reaping the full benefits of new banking laws, which go a long way in ensuring a more efficient supervisory and regulatory environment.

  • Adopting a clear public policy related to microfinance, the key role of which is recognized in the PRSP. An expansion of microfinance activities is predicated on further reforms of the regulatory and supervisory framework, while creating an environment conducive to the development of small businesses. In particular, it would be important to (i) streamline entry and exit procedures for institutions performing microfinance activities so as to ensure more regular financing of beneficiaries; (ii) reinforce capacity-building programs for the microfinance institutions and their supervisors; (iii) ensure adequate capitalization of these institutions; and (iv) enhance the financial institutions’ law on microfinance activities and the supervision of microfinance institutions, in particular by developing special supervision procedures compatible with these institutions’ ability to monitor risks and with the quality of their structure and personnel qualifications. There is also a need to raise the awareness of beneficiaries about the importance of preserving the ability to take risks.

  • Strengthening the judicial system to enable the private sector to benefit from the comfortable liquidity position of commercial banks. Presently, the private sector is deemed to have little confidence in the court system. It is important to alleviate the perception that judges lack autonomy and that the court system is slow in resolving disputes. In doing so, the great potential offered by the microfinance sector would be tapped and commercial banks would likely be more forthcoming in providing financing to the private sector.

  • Exploring further possibilities of developing new financial products to ensure greater mobilization of domestic savings and address the financing need of small- and medium-sized enterprises (SMEs), while establishing an adequate regulatory framework so as to ensure success of this operation. Financial products available in Djibouti are limited and consist mainly of deposits with commercial banks. In the current context, SMEs lacking solid equity capital are unable to solicit banks for medium- and long-term financing. To finance their capital investments, they apply for short-term credits (cash facilities) that are usually renewable at high interest rates, which is detrimental to their cash flow.

  • Maintaining and enhancing the comparative advantage imparted by the CBA by (i) continuing development of operations that have established the good reputation of the Djibouti financial system; (ii) specializing in innovative financial products for which it would have a regional monopoly, or which would be needed by some regional operators; (iii) establishing agreements with regional banking or insurances institutions, particularly in Ethiopia, including becoming a shareholder in these institutions; and (iv) promoting national banking products and services with neighboring countries and with regional economic institutions, such as the Common Market for Eastern and Southern Africa (COMESA).

APPENDIX I: Recent Monetary Developments

51. Following a period during which broad money and nominal GDP evolved with similar trends from 1990 to 1996,24 broad money and nominal output displayed opposite trends from 1997 to 2000. While GDP was growing moderately during the latter period, broad money declined steadily (Figure I.5). This decline in broad money was most likely the result of the erosion of the fiscal position. The rapid accumulation of budgetary arrears and forced borrowing from public agencies to cover budget deficits during most of the 1990s weighed heavily on the financial situation of private suppliers, public enterprises, and civil servants. Since deposits with commercial banks are the only financial instrument available in Djibouti, the worsening in the financial position of these economic agents led to the decline in broad money as well as a shift from longer to shorter maturity deposits. At the same time, uncertainty about the economic situation and the lack of confidence toward the government appear to have contributed to some capital outflows, as evidenced by the high level of negative errors and omissions in the balance of payments.25 Furthermore, the composition of deposits changed in favor of foreign currency, the share of which, in broad money, rose from 36 percent in 1994 to almost 50 percent in 1999 (Figures 1.8 and 1.9). In the absence of other factors, this development appeared to reflect the growing preference for cash vouchers (an instrument denominated in U.S. dollars in bearer form), and some erosion in confidence in the domestic currency.

Figure 1.5.Nominal GDP and Broad Money, 1984–2002

(Niperian logarithm indices, 1990=In(100))

52. During the period from 2000 to 02, broad money grew at about 12 percent per year, while credit to the private sector declined sharply. Combined with a significant increase in deposits, this decline in credit to the private sector led to a sustained increase in net foreign assets of commercial banks. Furthermore, the recent strong growth in broad money did not cause inflationary pressures, as evidenced by a CPI inflation rate that remained close to 1 percent (Figure I.6) and a money velocity (as measured by the ratio of broad money to nominal GDP) that declined by about 7 percent (Figure I.7). These elements could signal a recovery in the liquidity of the economy and appear to be a reversal of trends observed during the second half of the 1990s.

Figure I.6.Inflation and Broad Money

(Annual percent change)

Figure I.7.Inflation and M2 Velocity

(Annual percent change)

53. The stabilization and then reversal of the declining trend in broad money started in 2000, essentially because of the recovery in the economic activity, mostly attributable to the transport sector (subsequent to Ethiopia’s decision to channel its transit trade through the port of Djibouti). In addition, with an improvement in fiscal management, the accumulation of budgetary arrears subsided and was baited in mid-2001. This undoubtedly contributed to a rise in deposits and broad money, which grew at a faster pace than nominal GDP. These movements also allow for some catching-up of real money balance toward a level more consistent with the level of economic activity in Djibouti. Furthermore, large (unidentified) capital inflows (part of errors and omissions in the balance of payments) may also have contributed to money growth.

54. Deposits grew significantly in response to an improvement in the liquidity situation of households and the limited range of available financial products. Time depoisits contributed to most of the total increase in deposits. In addition, the rising trend in the share of foreign currency deposits was halted after 2000, although its level remains high at 48.5 precent in 2002.

55. While foreign currency deposits represent only part of foreign currency holdings in Djibouti,26 and do not distinguish between domestic residents and foreign holders, its relatively high level leads one to wonder about the scope of currency substitution. With a substitution ratio (foreign currency deposits-to-broad money ratio) of about 36 percent in 1995, Djibouti already stood among the highly dollarized economies examined in Baliňo et. al. (1999), such as Argentina, Nicaragua, or Croatia. The substitution ratio had been on an increasing trend until 1999 and has remained high since then. Figures I.10 and I.11 depict the trend of currency substitution in Djibouti by using the ratio of foreign currency deposits (FCD) to both M1 (base money) and M2 (broad money). The large gap between the FCD-to-M1 ratio and the FCD-to-M2 ratio reflects the fact that FCD accounts for about half of broad money and, hence, a large part of changes in broad money is explained by changes in FCD.

Figure I.8.Demand and Time Deposits, 1991–2002

(In millions of DF)

Source: Djibouti authorities; and IMF staff calculations.

Figure I.9.Currency Composition of Deposits, 1994—2002

(In percent of broad money)

Source: Djibouti authorities; and IMF staff calculations.

Figure I.10.Djibouti: Foreign Currency Deposits Ratios, 1990-2002

(In percent of money)

Sources: Djibouti authorities; and IMF staff calculations.

56. Currency Substitution may benefit the economy by enhancing reintermediation and promoting financial deepening. However, by inducing a reduction in the real demand for domestic currency, it may involve a loss of seigniorage, the profits accruing to the monetary authority from issuing the legal tender. Although these negative impacts may be limited, their growing importance, as shown by the Various ratios discussed above, raises some concerns. The evolution of these ratios may suggest that, despite progress achieved through financial sector reforms under the two IMF programs, the fixed exchange rate regime in place, a low level of inflation, and a continued political stability, the Djibouti people are still not fully confident about future developments.

Figure I.11.Djibouti: Foregn Currency Deposits, 1994-2002

Sources: Djibouti authorities; and IMF staff calculations.

57. Although commercial banks have a comfortable liquidity position, credit to the private sector has been low and declining since end-2000. These developments reflect commercial banks’ cautious approach in view of a high level of NPLs and weaknesses in the judiciary system that impedes recovery of NPLs, as well as uncertainty about the economic situation (Figures 1.12 and 1.13). Moreover, a large share of documentary credits (mainly trade credits) was gradually captured by other markets, particularly Dubai, after the Somali border was closed in early 2001, and was not regained after the border reopened later in that year.

Figure I.12.Non Performing Loans, 1994-2002

(In percent of total loans)

Sources: Djibouti authorities; and IMF staff calculations.

Figure I.13.Deposit and Credit, 1990-2002

(In millions of DF)

Sources: Djibouti authorities; and IMF staff calculations.

58. On the demand side, high lending rates practiced by commercial banks discouraged the development of credit to the private sector. The spread between the domestic lending and deposit rates widened sharply from 1995 to 2002 (Figure I.14). On the other hand, the lending rates have been only partially responsive to the decline in international rates. On the other hand, the international rates in the late 1990s was accompanied by a corresponding (but partial) reduction in domestic rates on deposits, consistent with indicators of some increase in the rist premium and commissions changed to commercial banks’ customers in Djibouti.

Figure I.14.Djibouti: Interest Rates Spread, 1990-2002

Source: Djibouti authorities; and IMF staff calculations.

59. From 1995 to 2002 the interest rate spread27 widened by about over 5 percentage points, from 3.4 percent in 1995 to 8.8 percent in 2002. This is consistent with banks’ increasing provisioning for NPLs. This may also reflect a declining winning competition among banks, as evidenced by the further increase in the spread starting in 1999 when the number of operating banks declined from five to three. On the other hand, the fall in the international rates in the late 1990s and early 2000s was accompanied by a corresponding (but partial) reduction in domestic rates on deposits, consistent with indications of some increase in the risk premium and commissions charged to commercial banks’ customers in Djibouti (Figure I.15).

Figure I.15.Djibouti. Domestic and Foreign Interest Rates, 1990-2002

(in percent)

Source: Djibouti authorities; and IMF staff calculations.

60. Aware of the need for a more active credit policy favoring productive activities, and concerned about collusion among banks in setting interest rates, the authorities introduced in August 1999 at the initiative of the bankers’ association corrective measures to preserve a competitive financial market. These included several instructions to banks to cease coordination of interest rate structures and to publicize and report their structures to the BCD. Parallel instructions were issued regarding bank fee structures which also were subject to collusion. However, the effectiveness of the these measures was limited by the official stance of BCD not interfering with the freedom of the commercial banks to determine credit policy.

61. As a result of opposite developments in deposits and credits, commercial banks accumulated large amounts of net foreign assets (Figure I.16), which increased by about US$50 million in 2001 and a further US$45 million in 2002 (a cumulative 7.6 percent of GDP, or 8.6 months of imports of goods and services). The coverage ratio of the currency board, as measured by the ratio of gross foreign assets of the BCD over the monetary base and government deposits at the BCD, has been slightly fluctuating around 115 percent since end-2000.

Figure I.16.Broad Money and Net Foreign Assets, 1994-2002

(In millions DF)

Sources: Djibouti authorities; and IMF staff calculations.


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Per capita income is estimated to have declined by about 3 percent per year from 1994 to 2002. The 2002 household living standards survey (EDAM-IS2) shows that more than onethird of Djibouti households live below the extreme poverty line, spending less than two dollars per day. This survey also estimates that about 60 percent of the labor force is unemployed.

prepared by jemma Dridi (MCD).

However, the development of a financial system is itself endogenous to growth, thus the lack of development in not necessarily a cause of low economic growth. Box I.1 provides a brief overview of the literature on the relationship between financial sector development and economic growth.

The share of the financial sector is measured by the ratio of value added generated by banking and insurance activities to GDP.

Based on a large sample of developing countries, Beaney and Fielding (2002) found that the 52 pegged exchange rate countries averaged inflation rates far lower than those experienced by the 28 flexible-rate countries. The standard deviation of output growth is on average a little higher under pegged rates. The standard deviation of inflation is, however, much higher in the flexible-rate sample.

Although the Djibouti franc is anchored to the U.S. dollar, it is worth noting that consumer price indices (CPIs) for Djibouti and the United States have evolved at different rates, with inflation in the United States significantly lower and less volatile from 1990—99 and slightly higher than in Djibouti thereafter. The difference in inflation trends may reflect the difference in the mix of goods produced and consumed, as well as well demand or supply shocks in the two countries.

About eight insurance companies existed before December 2000, when a new regulatory law, promulgated a year earlier, came into effect. Most of these companies fell short of meeting the new requirements (e.g., in terms of technical reserves, assets, liabilities, and tariffs) and were constrained to cease activities.

Appendix I provides a detailed overview of monetary developments from 1990 to 2002.

The deposit transformation rate is defined as the ratio of total credits to total deposits.

The Djibouti Development Bank (BDD) was the only specialized bank in providing long-term credit and equity to the real sector. The BDD was liquidated in 2000.

Both banks follow prudential regulations from their headquarters, which are deemed to be stricter than those imposed by the BCD. Most domestic banks failed to observe prevailing regulations and were victims of non rigourous management, especially in screening and monitoring the beneficiary of loans.

However, the revised banking laws were not yet adopted by the parliament.

Informal finance can be seen as a positive reaction to the inadequacy and lack of flexibility of the banking sector with regard to low and irregular income earners.

The Grameen Bank provides credit to the poor in rural Bangladesh without any collateral. Its banking system is based on mutual trust, accountability, and participation.

Articles 11 and 16 of the this law indicate that any organization that starts a microfinance program needs to sollicitate an official operation agreement, even if the conditions for its financial viability are not entirely met and/or it is unable to provide reliable data in line with BCD’s regulations.

In the past, banks’ reporting to the BCD was not done in a systematic manner.

The provision was already in the previous law but never used, and was inadvertently kept in the revised BCD statutes.

Namely, a high level of NPLs, Djibouti’s role as a regional commercial and financial center, and the preservation of the existing currency board.

This training program began in June 2002 and continued through December 2002.

These include recent developments in the Basle 2 agreement with regard to new prudential standards, new financial products, and various aspects of microfinance.

This ratio increased further subsequent to the reduction in 2001 of the minimum level outstanding bank credits, which was brought to DF 3 million.

The authorities indicated that they intend to take a small equity share of 20–30 percent (as they do in a domestic commercial bank) and would share the profits and losses of the fund in proportion to its capital contribution. Moreover, the government’s contribution would be financed entirely with external concessional resources.

Djibouti’s real estate market is depressed, and it is feared that hastening the sales of real estate properties would lead to large capital losses.

Levine (1999) found that various legal determinants were significantly correlated with the indicators of financial development, having expected signs, despite a difference in their significance levels. He concluded that countries with legal and regulatory systems assuring a high protection of creditors tend to have more-developed financial intermediaries.

The only exception was 1992 when GDP increased at about 3 percent, while broad money declined by about 2 percent, reflecting a fall in the net official foreign assets. The ratio of net official foreign assets to the monetary cover decreased to about 130 percent, from about 170 percent at end-1991. The exceptional level of monetary coverage in 1991 is attributable to important transfers from Saudi Arabia to compensate Djibouti for its support to allies during the war to liberate Kuwait from the Iraqi invasion. Most of these transfers were used by the Djibouti authorities to finance the civil war.

Negative errors and omissions (including short-term capital flows) in the balance of payments were estimated at an average 2 percent of GDP a year between 1990 and 2000, with a pick up to about 7 percent of GDP per year from 1996 to 1998.

A more comprehensive measure of the stock of foreign currencies held by Djibouti residents conventionally should be viewed in terms of the volume of foreign currencies circulating in Djibouti, foreign currency deposits in the domestic banking system and cross-border deposits held at foreign banks. Since data on the last two components are not available, foreign currency deposits is the only proxy for measuring foreign currency holdings in Djibouti.

The interest rates spread is measured by the difference between the minimum lending rate and the maximum deposit rate.

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